UPDATE 2-Sterling tops $1.35 on Brexit deal hopes, dollar weakness

LONDON, Nov 30 (Reuters) - Sterling topped $1.35 on Thursday, hitting a two-month peak, as hopes grew of a deal between Britain and the European Union at a summit next month.

The dollar’s weakness in late New York trading exacerbating the pound’s gains.

“The dollar has been whacked across the board and cable has been benefiting from that, but sterling was already strengthening on speculation that the UK is close to an agreement on the Irish border,” said Adam Cole, chief currency strategist at RBC Capital Markets.

The dollar retreated from the session highs of 93.505 against a trade-weighted basket of its rivals on Thursday and was trading at 92.875.

EU leaders are preparing to offer a two-year Brexit transition deal as early as January after negotiators were close to a deal over the Northern Ireland border, The Times newspaper said on Thursday, citing EU sources.

Avoiding a so-called “hard border” on the island of Ireland that many fear could disrupt the peace in Northern Ireland is the last major hurdle before talks can move to negotiations on Britain’s future trade relationship with the bloc.

Sterling extended a 3-day rally to its highest level since Sept. 25 to $1.3549 taking its gains since late Tuesday to more than 2.5 percent.

“The news triggered a lot of stops that pushed the currency higher. This would be tremendously bullish for sterling,” said ACLS Global strategist Marshall Gittler.

Brexit supporters accused Prime Minister Theresa May on Wednesday of being far too weak with the European Union after reports that she is ready to pay what Brussels is demanding to settle the divorce bill to leave the bloc.

But investors have welcomed the higher offer from May, with many fearing a “disorderly Brexit” - one without a deal - could spook financial markets, sow legal chaos and harm the British and EU economies by disrupting trade ties and cross-border supply chains.

“A key short-term downside risk appears to be abating,” wrote UBS macro strategist Lefteris Farmakis, in a research note on Thursday.

“Now the prospect for a fairly long and smooth transitional period has emerged. Should a transition deal be confirmed, downside risks for the currency will be firmly pushed back in time. And equally, the alleviation of imminent tail risks should support sterling, at least in the short term.”hit a three-week high of 87.76 pence.

Those gains helped pull up the Bank of England’s trade-weighted sterling index, which tracks the British pound’s effective exchange rate, to 78.8, its highest since May 19.